Economy needs permanent tax reforms, cuts

August 16, 2011

Tax reform is in the air. One proposal floating around is to eliminate or reduce the tax deduction for home mortgage interest. About 35 million homeowners use the deduction to reduce their yearly tax bills. The total deduction amounts to about $131 billion a year.

During the recent wrangling in Washington over the the budget and debt ceiling, one reform proposal came from the “Group of Six” senators — three from each party — that worked out part of the agreement. According to McClatchy News Service, the senators “proposed lowering the limit on mortgages eligible for the deduction from $1 million to $500,000 and restricting the tax break only to primary residences.” Other deduction reform plans have come from the Tax Policy Center and from President Barack Obama’s National Commission on Fiscal Responsibility and Reform.

The Reason Foundation, a libertarian think tank, also just came out with a study, “Unmasking the Mortgage Income Deduction: Who Benefits and by How Much?” The study found that the deduction actually doesn’t do much to promote homeownership. The main beneficiaries are people who would buy homes anyway, and the tax break encourages them to buy larger homes than they otherwise would. Those on the margin – renters seeking to buy – can’t benefit until they actually purchase a home.

Reason looked at several reform options. Simply eliminating the deduction would result in a sizable tax increase that would slam not only homeowners, but the national economy. An alternative would be a “revenue neutral” reform in which the deduction would be completely eliminated, but the extra tax money would go to reducing overall tax rates about 1.4 percentage points. The average income tax rate would fall to 16.8 percent from 18.2 percent (using figures from the 2008 tax year).

Most people would enjoy tax cuts. Unfortunately, taxpayers currently taking the deduction would see their tax bills rise by $646 to $864 a year. That’s unacceptable. During a recession, nobody’s taxes should go up.

A better idea is to include the elimination of the deduction as part of overall tax cuts. Anthony Randazzo, Reason’s director of economic research and co-author of the study, told us, “That’s absolutely a solution. Taxes could be cut by income class enough so no tax goes up.”

But what about the $1.5 trillion yearly federal budget deficit? That remains a problem of way too much spending. The more serious problem now is the lack of economic growth. A major cause of the stagnation is the lack of certainty over the tax code. Because President Bush’s tax cuts were extended to 2013, not made permanent, families and businesses can’t calculate their economic futures.

What’s needed to get the economy growing again is comprehensive tax reform and reduction — permanent this time. Provided nobody’s taxes are raised overall, getting rid of the mortgage interest deduction should be part of that mix.